https://www.wsj.com/articles/fed-floats-changes-to-volcker-rule-on-big-bank-trad

Question

https://www.wsj.com/articles/fed-floats-changes-to-volcker-rule-on-big-bank-trading-restrictions-1527705603?mod=searchresults&page=1&pos=2

The Federal Reserve has proposed to ease the Volcker rule for banks that was designed to curb risky trading, resulting in fewer audits of individual securities and derivatives transactions and allowing banks more time to focus on buying and selling instead of compliance. The current practices are also deemed costly and confusing. Critics are concerned that there that this change would allow banks to engage in risky trading, but it is believed that this concern can be addressed by setting limits on traders aligned with expected customer demand. Proponents believe this is a rationalization of the current programs.

     Included in the changes from auditing individual transactions, is the elimination of the presumption that positions held for less than 60 days violated the rule unless bankers prove otherwise. This would be replaced with regulators looking to how positions are defined under accounting rules to determine if they are considered short term trades. Also there would be the presumption of compliance if traders remain within limits set by trading desks, with the government periodically reviewing these limits and their appropriateness.

1)The Volcker Rule for banks was established after the last financial crisis. Factors that lead to the crisis included a recession that was preceded by a period of rapid economic growth, rising stock prices, movements by banks into new lines of business, and a major crisis in the financial sector. Does the easing of the rule for banks lend itself to this path of another recession?

2) Is it the role of a financial institution to have this much involvement in the financial market and how does the changing of the rule impact that?

Explanation / Answer

1) The easing of the regulations that was set up as part of the Volcker Rules definitely increases the risk of bank entering into risky trades and positions and ultimately taking on too much leverage which could jeopardize their positions and also the entire financial system. Post the relaxation of the rules and the under the current circumstances of huge debt, it is quite possible that short term thinking may prevail and banks may again start taking highly leveraged positions in derivative markets to gain profits. Because of the increased debt levels, these positions may crumble faster than before as the margin of safety is lesser and we could again enter into a phase of recession.

2) The role of the financial institution is to ensure smooth credit flow in the economy. But to make huge profits, banks tend to take part in the financial markets to an extent which is not optimal. The Volcker Rules had put certain restrictions which had reduced the extent of these involvements, but now there may again be such extensive involvements and which can potentially end in financial disaster.

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